Warren Buffett famously said, 'Volatility is far from synonymous with risk.' It's only natural to consider a company's balance sheet when you examine how risky it is, since debt is often involved when a business collapses. As with many other companies Shanghai Zhangjiang Hi-Tech Park Development Co., Ltd. (SHSE:600895) makes use of debt. But is this debt a concern to shareholders?
What Risk Does Debt Bring?
Debt is a tool to help businesses grow, but if a business is incapable of paying off its lenders, then it exists at their mercy. Ultimately, if the company can't fulfill its legal obligations to repay debt, shareholders could walk away with nothing. However, a more frequent (but still costly) occurrence is where a company must issue shares at bargain-basement prices, permanently diluting shareholders, just to shore up its balance sheet. Of course, plenty of companies use debt to fund growth, without any negative consequences. When we think about a company's use of debt, we first look at cash and debt together.
What Is Shanghai Zhangjiang Hi-Tech Park Development's Debt?
As you can see below, at the end of June 2024, Shanghai Zhangjiang Hi-Tech Park Development had CN¥28.9b of debt, up from CN¥24.5b a year ago. Click the image for more detail. On the flip side, it has CN¥4.02b in cash leading to net debt of about CN¥24.9b.
How Healthy Is Shanghai Zhangjiang Hi-Tech Park Development's Balance Sheet?
Zooming in on the latest balance sheet data, we can see that Shanghai Zhangjiang Hi-Tech Park Development had liabilities of CN¥15.2b due within 12 months and liabilities of CN¥22.4b due beyond that. Offsetting this, it had CN¥4.02b in cash and CN¥275.4m in receivables that were due within 12 months. So it has liabilities totalling CN¥33.3b more than its cash and near-term receivables, combined.
When you consider that this deficiency exceeds the company's CN¥27.7b market capitalization, you might well be inclined to review the balance sheet intently. In the scenario where the company had to clean up its balance sheet quickly, it seems likely shareholders would suffer extensive dilution.
We use two main ratios to inform us about debt levels relative to earnings. The first is net debt divided by earnings before interest, tax, depreciation, and amortization (EBITDA), while the second is how many times its earnings before interest and tax (EBIT) covers its interest expense (or its interest cover, for short). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).
Shanghai Zhangjiang Hi-Tech Park Development shareholders face the double whammy of a high net debt to EBITDA ratio (17.1), and fairly weak interest coverage, since EBIT is just 1.9 times the interest expense. This means we'd consider it to have a heavy debt load. The silver lining is that Shanghai Zhangjiang Hi-Tech Park Development grew its EBIT by 155% last year, which nourishing like the idealism of youth. If that earnings trend continues it will make its debt load much more manageable in the future. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately the future profitability of the business will decide if Shanghai Zhangjiang Hi-Tech Park Development can strengthen its balance sheet over time. So if you want to see what the professionals think, you might find this free report on analyst profit forecasts to be interesting.
Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So we always check how much of that EBIT is translated into free cash flow. Over the last three years, Shanghai Zhangjiang Hi-Tech Park Development saw substantial negative free cash flow, in total. While investors are no doubt expecting a reversal of that situation in due course, it clearly does mean its use of debt is more risky.
Our View
On the face of it, Shanghai Zhangjiang Hi-Tech Park Development's net debt to EBITDA left us tentative about the stock, and its conversion of EBIT to free cash flow was no more enticing than the one empty restaurant on the busiest night of the year. But on the bright side, its EBIT growth rate is a good sign, and makes us more optimistic. Overall, it seems to us that Shanghai Zhangjiang Hi-Tech Park Development's balance sheet is really quite a risk to the business. For this reason we're pretty cautious about the stock, and we think shareholders should keep a close eye on its liquidity. The balance sheet is clearly the area to focus on when you are analysing debt. But ultimately, every company can contain risks that exist outside of the balance sheet. Be aware that Shanghai Zhangjiang Hi-Tech Park Development is showing 3 warning signs in our investment analysis , and 1 of those is potentially serious...
If, after all that, you're more interested in a fast growing company with a rock-solid balance sheet, then check out our list of net cash growth stocks without delay.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
